Stock Market Crash! Blog

How To Profit From the Interest Rate Ascent (Pt. 1)

In the preceding post, I promised to show how to profit from the collapse of bonds and consequent rise in interest rates. Not surprisingly, I recommend shorting interest rate sensitive stocks. I will detail 3 stock classes that are great short candidates, in a mini-series of blog posts, with one post for each of the 3 classes.

1)Homebuilder Stocks

The housing bubble of last six years has been fueled largely due to mortgage rates being at multi-decade lows. Homebuilding stocks have greatly benefited from the overheated real estate market. A homebuilder stock, Hovanian Enterprises, has risen a remarkable 2,233%, Beazer Homes rose a respectable 1,066%, and Lennar Corp a "measly" 650%.

Now, interest rates are heading back up, reversing the process which caused homebuilders good fortunes.

A look at the Dow Jones Home Construction Index ($DJUSHB) shows a bearish head and shoulders top reversal, which is looks earily like an upside down chart of the 30-Year Treasury Bond yield chart, from my last post. Mere coincidence? I think not. Interest rates are inversely correlated with housing stocks. See here:

$DJUSHB:



30-Year Treasury Bond yield. Notice how well the right & left shoulders and head corresponds with those of $DJUSHB:





Our previous post detailed the profit target measuring technique as applied to a head and shoulders bottom reversal, and the same applies for $DJUSHB's head and shoulders top, albeit in an upside-down manner. You must subtract the vertical distance of the widest point of the pattern from the price where the market breaks below the neckline support level. This gives us a price target of 530 from the current 866. The market is likely to drop to this point, form a flat trading range, and embark on a continuation of the previous trend.

Before entering a trade, the most prudent move is to wait for a strong break below the 850 necline support. This confirmation is necessary to see if the head and shoulders is indeed valid. What I find notable is how 30-Year T-Bond yields already broke above their neckline resistance, possibly foreshadowing what's to come for the $DJUSHB.

Upon a confirmed break below 850, the best bet is to short sell one of the stock components of the $DJUSHB index. These include Beazer Homes, Hovanian Enterprises, Lennar Corp., Centex Corp., Pulte Homes., and D.R. Horton Inc., to name a few.

The risk-management approach I would take is a buy stop-loss order placed at a point in the underlying stock that corresponds with the neckline support of the parent $DJUSHB index. A failure would be if the $DJUSHB rose above the neckline.

Have patience- part 2 and 3 of this series is coming soon!

Click here to check the updated $DJUSHB index chart at StockCharts.com